What are Search Funds?
An alternative to take into account for those entrepreneurs who are thinking of selling their company.
Search Funds” or “Search Funds” are spreading rapidly in our market. Developed in the United States for more than a decade, it is an instrument through which one or several young entrepreneurs with some business experience decide to join together and raise capital for the acquisition of a single company. It is an instrument that is clearly different from investment funds, as a single acquisition is made and the entrepreneur or “Searcher” leads the acquired company as CEO.
How does it work?
The “Searcher”, thanks to his or her academic and professional background, receives a minimum initial capital from independent investors and investment funds; ideally around 15 investors. This initial contribution should be sufficient to cover his or her salary and other management costs to carry out the search for the ideal company to acquire.
Usually the maximum search time is two years and investors are committed, but not obliged, to invest in the selected company. It is a key aspect for the “Searcher” to surround himself with investors with extensive experience in different fields who can provide business and sector knowledge and contacts, as it will be of great help to have all these assets at the time of relaunching the acquired company.
Search Fund target companies are usually SMEs, as they fall off the radar of investment funds or large strategic buyers. They are usually companies without a growth plan or with succession problems, operating in sectors with low swings and low technology risk. In any case, there is no written rule, so we can find search funds interested in technology companies or simply in companies where the current partners want to make cash and gradually leave their day-to-day work in the company.
Investment criteria are usually agreed with all investors. The selected companies must have robust financial statements, as they must be able to generate attractive returns for investors. Companies in trouble or operating in declining sectors are not targeted by these funds.
Once the company has been selected and presented, investors can decide whether or not to invest in it. The investment partners will have preferred shares while the “Searcher” will have ordinary shares. The ultimate goal of this structure is to ensure the Searcher’s full commitment to growing the company.
The acquisition of the company is usually financed by partner contributions and bank debt. Debt never exceeds 60% of the total investment, but is necessary to improve the expected returns. Partners who do not invest in the company usually sell their shares and leave the Search Fund.
It is the company incorporated as the “Search Fund” that acquires 100% of the shares of the target company. If it is agreed that the owners of the acquired company will retain a percentage of shares, they will keep them in the Search Fund company. In this way all investors, including the seller, are on an equal footing and it is advisable to avoid majorities. The ultimate goal is that all shareholders are aligned to achieve the company’s objectives.
What are the keys to investment success?
For the “Searcher” it is important to have well-defined, logical and acceptable investment criteria. It is not easy to find interesting companies in Spain that are willing to understand this concept and sell to a Search Fund. In the US, 25% of searchers tend to fail in their search for the right company.
The selected company must win the hearts of at least 10-12 of the investors who initially trusted the searcher. It is key that the seller understands the model, especially in terms of its initial valuation, as the model can easily create confusion
. There must be a good understanding between the seller and the “Searcher” as the permanence of at least a couple of years of the current partners is an essential condition. This is often a key requirement and is usually linked to the payment structure of the company price. There are also often deferred payments linked to results, the so-called “earn-outs”.
As mentioned above, it is important that the partners who finally invest to acquire the company contribute knowledge in different areas and that there is no majority shareholder.
As on so many other occasions, the composition of the board of directors will be key to the success of the project. The aim is to grow and generate interesting returns for the investor. The contribution of knowledge from all board members will be key to success, more so than in any other company.
An alternative to consider
From our point of view, this model can be interesting for those entrepreneurs who have in mind to sell the company, but with the idea of remaining involved in the project for four or five years. It also offers an advantage over traditional investment funds, as there is not necessarily a requirement to sell in the short term, so there is less pressure to achieve the objectives set. And finally, it can also be a good model for those technology entrepreneurs who see difficulties in taking the company to the next level of professionalisation, but want to continue to be part of the project.
